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December 21, 2011

Outlook 2012: Equities–Top 5 Trade Ideas for the New Year

Despite 2011’s volatility, stocks in 2012 could see opportunities via the S&P 500, dividend-payers and more

Against a backdrop of nerve-wracking stock market volatility in the second half of 2011, wealth managers, investment banks, and research and investment firms have come out in droves to give their best equities predictions for the new year.

Here’s what the experts are saying about the investment outlook for stocks in 2012:

Bank of America Merrill Lynch Global Equity Strategist Kate Moore, whose 1350 S&P 500 target is at the top end of recent trading ranges, says that the balance of risk versus reward for equities is improving, but a long-term bull market in equities requires a “good” bear market in bonds–and we’re not in that good bear market yet.

“The next major inflection point in bond yields will occur when the U.S. economy is strong enough for the Fed to raise policy rates–and we see a recovery in the property, banking, and labor markets,” Moore says. “Until then, global equities will be in a big fat trading range.”

For now, BofA-Merrill maintains an underweight equities position as the global economy is crushed by European debt troubles and government policymakers’ inability to reach agreements on taxes and spending.

2) Buy Dividend-Paying Stocks (and Say Hello to Technology). High-quality, high-return-on-equity companies with strong free cash flow are an area of potential interest for investors in 2012 because they will pay attractive dividends, says MFS Chief Investment Strategist James Swanson.

“As the world teetered on the brink of financial disaster in 2008, the short-term paper market–the ATM for corporations, in essence–froze. Corporate America does not want to be caught again not being able to finance short-term needs and payrolls," Swanson says. ”All that cash has to go somewhere."

That “somewhere,’ for Swanson, includes stock buybacks, mergers and acquisitions and further corporate deleveraging of outstanding debt.

Swanson believes the U.S. expansion since the Great Recession of 2008 is roughly at midcycle and doing far better than headlines would suggest. The U.S. corporations that comprise the S&P 500 are enjoying record profitability, he notes, and cash on their balance sheets has not been this high since just after World War II.

Swanson especially likes the Technology sector, saying it’s a good destination for investment flows. In addition to under-spending and pent-up demand on hardware and software, the Tech sector has matured and now offers investors a more defensive play. The sector has little to no debt, is the second most leveraged to the global economy (with the Energy sector at No. 1) and has profit margins that are more than double what they were a decade ago. Furthermore, valuations are roughly in line with the broader market, which is not nearly as healthy in terms of cash flow, margins and leverage.

3) Go Global. Making gains in 2012 will require a global outlook that identifies outperforming managers in every sector and region, according to Russell Investments’ global Chief Investment Officer Pete Gunning.

“Gaining access to nontraditional securities through alternatives will also be a key potential return enhancement strategy,” Gunning says. “In a world of increased volatility and lower returns, we believe a dynamic approach to investing will increasingly become the norm for successful investors.”

The global economy may very well find itself weathering “a normal size recession” in Europe, said Ethan Harris, co-head of Bank of America Merrill Lynch Global Economics Research. However, ING Investment Management CIO Paul Zemsky says the U.S. itself won’t slip into recession–“it just doesn’t look like it’s going to happen—though Zemsky also foresees a “normal” European recession.

“The U.S. faces its own challenges,” notes Harris, “with gradual fiscal tightening and considerable uncertainty around policy after the election. As a result, while we expect solid 3% GDP growth in the current quarter, we look for growth to slow to just 1% by the end of 2012.”

Michael Hartnett, BofA-Merrill’s chief global equity strategist, added that “the very real risk” of policy mistakes causing a recession in the U.S. or a hard landing in China means that investors should conservatively allocate assets in 2012.

“Despite our short-term caution, however, we anticipate that global equities could rally by 10% next year from current levels, aided by liquidity, modest earnings growth and cheap valuations,” Hartnett says.

4) Take a Look at Small Banks. Keefe, Bruyette & Woods’ North America equity research group is moving its position on the Regional Bank group to overweight from market weight for the first time since it started coverage on the group four years ago.

“We believe this group has relative advantages versus its larger peers,” according to KBW analyst Jefferson Harralson and his team. “We believe the smaller banks have much greater license to return capital, have greater prospects for impactful M&A for both buyers and sellers, will have opportunities to increase market share from the large banks, and have no direct European exposure.”

10) Hedge consensus positions. Moore identifies the biggest positioning contrarian trade as long European banks/short Tech, and the biggest price action contrarian trade as long French banks/short U.S. Utilities.

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